Question

using the market for reserves graph and explain what happens to the quantity of reserves and the effective equilibrium fed funds rate in the following scenario. assume the original equilibrium is anove the interest on reserves floor

a. an open market purchase

Answer 1

An equilibrium interest rate that is above the interest rate floor makes the interest rate floor non-binding and non-effective, since a binding and effective interest rate floor is imposed higher than the equilibrium interest rate.

(a) An open market purchases increases the supply of reserves, shifting the supply curve rightward which decreases the Fed funds rate and increases the quantity of reserves.

In following graph, Fed funds rate (r) and quantity of reserves (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply curves of reserves, intersecting at point A with initial Fed funds rate r0 and quantity of reserves Q0. As supply increases, S0 shifts right to S1, intersecting D0 at point B with lower Fed funds rate r1 and higher quantity of reserves Q1.